The market reality today of intense merger and acquisitions activity, can create a significant challenge in outsourcing contract negotiations. Outsourcing contracts should contemplate potential transactions, including a potential sale of the outsourcer and of the customer. Future acquisitions and divestitures by the customer should also be considered.
Acquisition of an Outsourced Customer
When an acquisition is being considered or occurs, the acquirer and the seller may already have an outsourcing agreement in place. Attorney Bill Deckelman, shareholder in the Austin law firm of Munsch Hardt Kopf & Harr, P.C. states: “Typically, the outsourcing contract will have had a lengthy term when it was entered into; if multiple years remain in the contract term, the contract will represent a liability in the form of business committed exclusively to the outsourcer holding the contract. In this respect, the contract represents a constraint on the flexibility of the acquirer.”
According to Deckelman this scenario is not unusual, but having an outsourcing agreement that addresses what would happen if there were a merger isn’t unusual either. Unless it is unlikely that a company will ever be acquired or acquire, it is a good idea to include a termination provision in the initial negotiations with the outsourcer, Deckelman notes. This stipulation generally falls into the category of termination for convenience.
“Acquirers who understand that technology is continuing to become a more critical business and competitive enabler, may view the existing outsourcing contract as a potential asset,” says Deckelman. They will look at the dollar value of the revenue stream to the outsourcer, include that with an analysis of the combined company’s IT strategic direction and needs, and determine whether they should redirect those dollars to other IT services–this works particularly well if the incumbent outsourcer has particular niche strengths that are critical to the IT strategy. The win-win is that the customer gets properly directed value from the outsourcing and the outsourcer retains its revenue stream and gets an opportunity to expand it’s relationship.
Options for the acquirer then include keeping the outsourcing contract or terminating the contract. The first option lets the acquired company’s outsourcing contract run its course. Acquirer’s typically will not like this option–usually it means redundant costs and makes it difficult to get streamlined financial and business reporting. Nevertheless this happens frequently and the time is used for transition planning.
The second option is allowed if the original contract includes a provision for the customer’s termination for convenience. If the acquirer decides to exercise this right, there will be a termination fee payable to the outsourcer. These fees can range in amount from strictly a recoupment of the outsourcer’s initial investment for the deal up to an amount that includes the investment recoupment plus a payment representing all or a portion of the outsourcer’s “lost profits” over the remaining term. It is not unusual for a termination for convenience provision to include restrictions designed to inhibit exercise of the right. Examples include a restriction on the customer’s right to exercise the convenience termination in the first two or three years of the outsourcing contract term; and the requirement that if notice of the termination is not given within a short period following the acquisition event, the customer waives the right to exercise the termination for convenience.
Future Divestitures and Acquisitions
If an acquisition is in your future, a provision will often be included in which the outsourcer agrees that the terms of the outsourcing contract, including price, will generally be extended to business operations acquired in the future by the customer. This provision is usually accompanied by a condition that the pricing may be equitably adjusted to account for additional investments or costs the outsourcer would be required to incur in conjunction with the new business (e.g., acquisition of IT assets, migration costs).
If divestitures are a consideration for the customer, it should negotiate arrangements for the event as part of the outsourcing contract. Leaving the details of this situation to be negotiated when the divestiture is to occur can result in a difficult negotiation and a strain on the outsourcing relationship. There are a number of ways to structure these provisions. One approach is a provision that permits a transition period during which the outsourcer and the acquirer of the customer’s divested business attempt to negotiate a new contract. During the transition period the outsourcer has agreed to allow the customer to “pass-through” the benefits of the contract to the acquirer to the extent that the outsourcer’s services pertain to the divested business. If the outsourcer and the acquirer are unable to reach agreement on a new contract by the end of the transition period, the customer is required to pay a partial termination fee to allow the acquirer to seek a new outsourcer.
When Your Outsourcer is Acquired
Customers aren’t the only ones that can be acquired. Customers often will negotiate certain rights and restrictions to address an acquisition of the outsourcer. Some of the customer concerns may be the potential change in management commitment, service level deterioration, financial status and technical capabilities of the acquirer, and whether the acquirer is a competitor of the customer.
Typical provisions will either require the customer’s consent to the outsourcer’s assignment of the contract to the acquirer or will grant a favorable termination right to the customer if the sale occurs without the customer’s consent through a merger or sale of stock of the outsourcer.
The ‘Assignment Clause’
Deckelman reminds us of the contract provision, the “assignment clause,” that typically appears as a very innocuous clause in the General or Miscellaneous section at the end of an outsourcing contract.
These clauses will generally require that the customer or both the customer and the outsourcer obtain the consent of the other party prior to ‘assigning’ the contract to a third party. A voluntary assignment of a contract occurs in an acquisition context when the acquirer is purchasing the assets of a company. However, mergers and stock sales may trigger a consent requirement as well. The particular state law governing the contract may determine the interpretation of this clause as well. It is critical that a party’s legal counsel drafts this clause carefully to ensure that the parties’ intentions are met.
Addressing these issues during the initial negotiations does not assure that some renegotiations won’t need to be done. “Too assume that would be simplistic and naÔve,” Deckelman says. “Usually some renegotiation is required because almost inevitably there will be some additional investments or migration work if the outsourcer is kept. Also the outsourcer may need to take some assets off the hands of the acquired company. So it would be unusual to do a deal where you did not have to go in and do some renegotiation, perhaps not total restructuring, but some renegotiation.”